Don’t Get Slipped: A Short Guide to Slippage and Trading
Entering or exiting a trade, whether you are trading stocks, crypto or futures, you may find you get a different price than what you expected. This may be due to slippage. What is it and why?
Slippage occurs when a trade’s expected price differs from its executed price. In periods of higher volatility, slippage is more frequent.
What Causes Slippage?
Any instrument price on any market venue is susceptible to slippage because of delays. Your order is in a queue and prices are changing. So, if the bid/ask spread changes by the time a requested market order hits the market, the order has to trade at the new price.
In markets with low liquidity, order filling takes significant time. On the other hand, in a fast-moving, volatile market, the price of an instrument can change very quickly, before the order is filled.
There is often slippage during or around announcements regarding interest rates, monetary policy, or company earnings releases and corporate announcements. In short, events can increase the chances of traders experiencing slippage.
This is usually because there is a lack of consensus about what this new, potentially vital piece of information means for the asset in question, resulting in liquidity providers and other market participants pulling their liquidity to avoid traders with a potential informational advantage. Often, retail traders don’t even know a piece of news has been released, resulting in trades executed at poor prices.
Another example where slippage occurs is the case of stop runs. A stop run is when multiple stop orders are triggered, often cascading and triggering even more stops and traders are forced to unwind their positions. The execution of these is based on queues and orders are filled on available passive liquidity.
How to Avoid Slippage
The chances of getting slipped can be reduced in a number of ways.
The first and most obvious way is to trade markets with low volatility and high liquidity. A low volatility market indicates that the price will likely move less quickly. In contrast, a high liquidity market indicates that many active market players will be able to accommodate your transactions on the opposite side. As a result, your deal is more likely to be completed quickly and at the desired price if, for example, you restrict your trading to the busiest times of the day when liquidity is at its peak. However, clearly, this is not always possible or may not even match your strategy.
Another option is not to trade just before, during, or immediately after important news events that cause extremely high volatility. This obviously does not apply to news traders, who make the bulk of their profits from such events. But even so, some may prefer to wait for the dust to settle and price direction to become clearer.
A third option is to use other order types, such as stop-limits or limit orders. With limit orders you are instructing an exchange that you want to, for example, to sell a particular quantity but the order must not be executed at a worse price than you specify. It is not guaranteed that the order will be completely filled – or filled at all – but the price you want is, assuming that this price is reached. You may even experience positive slippage, where you get a more favorable price than expected.
Slippage will happen to any trader at least once. It is an inevitable part of trading that cannot be totally eliminated but the chances of it happening can be reduced.
As a final note, new traders sometimes confuse slippage with spread. A trader must understand price differences in order to maximize profits and avoid losses. If you want to learn about the basics of this fundamental subject and how it applies to trading, check out this article on “What is a Spread in Financial Markets?